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As the US financial landscape continues to evolve, regulatory changes are being introduced to safeguard consumer deposits and increase transparency. In September 2024, the Federal Deposit Insurance Corporation (FDIC) approved a notice of proposed rulemaking aimed at strengthening recordkeeping for bank deposits received from third party, non-bank companies accepting those deposits on behalf of consumers and businesses.
As explained by the FDIC, banks typically hold customers’ funds in an individual deposit account designated for that customer, such as a checking account. Non-bank companies, however, often deposit customer funds together into a single custodial account at a bank. These custodial accounts may hold funds of many thousands of consumers and businesses, and the bank may not readily know or be able to determine the individual owners of funds in the custodial account.
Under the proposed rule, FDIC-insured banks holding certain custodial accounts, as defined in the proposal, would be required to take certain steps to ensure accurate account records are maintained, to determine the individual owner of the funds, including a requirement to reconcile the account for each individual owner on a daily basis. These requirements, as well as others, apply if the bank uses a third party to maintain records.
The Bigger Picture
Custodial deposit accounts are increasingly used by non-bank entities, such as fintechs and payment service providers (PSPs), to hold customer funds. However, these arrangements are not without risks. A recent example underscores the need for stronger regulatory oversight: In April 2024, Synapse Financial, a startup fintech, declared Chapter 11 bankruptcy, leaving thousands of personal and business bank accounts frozen. The freezing of accounts was tied to an ongoing conflict between Synapse and its banking partners, stemming from disputed customer balance amounts. This incident highlighted how a lack of clarity in custodial account relationships can jeopardise customer access to their funds.
The FDIC has recognized these vulnerabilities and, although it has taken action in recent years to mitigate risks associated with third-party deposit relationships, the proposed rule introduces even more stringent requirements. The rule includes provisions that both banks and fintechs operating in the PSP space should consider carefully. At its core, the proposed rule aims to streamline recordkeeping and ensure that, in the event of a bank failure, the underlying owners of custodial deposits are clearly identified and receive prompt insurance payouts.
Why Should You Care?
Non-bank PSPs play a vital role as intermediaries between consumers and traditional financial institutions. Understanding the implications of the proposed FDIC regulation on custodial accounts is essential for several reasons:
- Customer trust: Customers depend on non-bank PSPs to safeguard their funds. In the event of a firm failure, any delay or confusion regarding deposit insurance claims could cause severely reputational damage and erode customer relationships. Maintaining robust communication and transparency during such crises will be crucial to preserving customer confidence.
- Compliance and operational efficiency: Non-bank PSPs must ensure that the banks they partner with fully comply with the new recordkeeping requirements. This includes maintaining accurate records of customer ownership and transactions. Failure to meet these standards can expose them to legal risks, potential penalties, and operational disruptions, which can strain resources and affect service delivery.
- Financial crime prevention: The proposed regulation strengthens oversight of custodial accounts, addressing vulnerabilities that could be exploited for financial crimes, such as money laundering. Implementing enhanced recordkeeping practices will help a non-bank PSP protect its business from potential risks and regulatory scrutiny. Ensuring that it has clear ownership records and transaction histories can significantly mitigate these threats.
- Regulatory accountability: With increased regulatory oversight, non-bank PSPs must maintain their own records in line with the new requirements. This means having a systematic approach to tracking customer funds and ensuring that records are consistent with those of banking partners. Non-compliance could lead to increased regulatory pressure and audits, further impacting operational stability.
Next Steps
To effectively adapt to the proposed FDIC regulations and safeguard operations, non-bank PSPs should consider the following steps:
- Conduct a compliance review: Evaluate current partnerships with banks to ensure they align with the new recordkeeping requirements. Identify any gaps in compliance that need addressing.
- Enhance recordkeeping systems: Invest in or upgrade your recordkeeping systems to maintain accurate, consistent records of customer ownership and transactions. This will help align with the regulatory expectations and improve operational efficiency.
- Implement training programmes: Ensure that staff are well-informed about the new regulations and understand their roles in maintaining compliance. Training on best practices for recordkeeping and financial crime prevention will likely be important.
- Develop a communication strategy: Develop clear communication strategies for informing customers about how their funds are safeguarded, especially in light of the proposed regulations.
- Monitor regulatory developments: Stay updated on any changes or additional guidance from the FDIC regarding custodial accounts. Regularly review policies and practices to ensure ongoing compliance as regulations evolve.
By proactively addressing these implications and taking the necessary steps to align with the new regulations, non-bank PSPs can better position themselves to navigate the evolving regulatory landscape while safeguarding their businesses and customer relationships.
